Download Chapter 4 Demand

Chapter 4
Demand
KEY IDEAS YOU NEED TO KNOW:
Define Demand
Describe the price effect
Describe the relationship between individual demands and market demands.
Define Price elasticity of demand, and list the factors that influence elasticity.
Explain the difference between the price effect and a chance in demand.
What is DEMAND?
Understanding the laws of supply and demand are central to understanding how the
capitalist economy operates. Since we rely on market forces instead of government forces
to distribute goods and services there must be some method for determining who gets the
products that are produced. This is where supply and demand come in. By themselves the
laws of supply and demand give us basic information, but when combined together the
are the key to distribution in the market economy... price.
DEMAND
Demand is comprised of three things (conditions).
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Desire
Ability to pay
Willingness to pay
Demand refers simply to the quantity of a particular good or service consumers are
willing and able to buy at different possible prices at a particular time. It is not enough to
merely want or desire an item. One must show the ability to pay and then the willingness
to pay. If all three conditions are not me then the demand is not real. This, by the way, is
the purpose of advertising. While many may want a product it is quite another to be
willing to pay. Advertising attempts to move a consumer from mere want to action. These
day even condition two may not stand in the way of a consumer. With the advent of
credit cards we are able to purchase products without the current ability to pay. Many
stores and car dealers even offer on the spot credit though the interest rate may be quite
high.
What factors alter your desire, willingness and ability to pay for products? Some factors
include consumer income, consumer tastes the prices of related products like substitutes
for that product of items that may complement that product.
Marginal utility - extra satisfaction a consumer gets by purchasing one more unit of a
product.
Diminishing Marginal Utility: The more units one buys the less eager one is to buy
more. Think of diminishing marginal utility this way. It is a hot summer day and your
sweating bullets. You come across a lemonade stand and gulp down a glass. It tasted
great so you want another. This second glass is marginal utility. But now you reach for a
third glass. Suddenly your stomach is bloated and your feeling sick. That's diminishing
marginal utility!
There are two types of changes in demand:
Changes in demand - change in the demand for a product that occurs when price drops.
Changes in the Quantity Demanded - change in the amount of a product demanded
regardless of price.
The difference is subtle but important. If the demand of ice cream goes up in the summer
it is because consumers demand has truly increased, clearly it is hot. In the case the
business can most likely raise prices without suffering a drop in sales. This is a change in
quantity demanded. If sales of ice cream were to increase in January as a result of a price
cut, however, the information we would be receiving is that the demand was artificially
manipulated. It really tells us that actual demand is low and that extra efforts had to be
made to increase sales. This is change in demand.
Probably the best place to see how demand works is an auction. An auction is a market
where goods are sold to the highest bidders. Because the items are sold one at a time,
buyers must quickly decide what prices they are willing to pay. If not, they risk seeing
the item go to someone else who is willing to pay more.
The law of demand is the result of not one pattern of behavior, but two separate patterns
that overlap.When there is a change in amount purchased (tied to demand) due to lower
prices and surplus spending money it is called the income effect. Income effect basically
happens when salaries are on the rise.
Another economic phenomenon tied to demand is the substitution effect. This states that
as prices drop consumers will buy more than usual at the expense of a different product.
Take a sale at the mall for example. If jeans are on sale for a great price consumers will
by extra jeans even if they had previously planned to buy something else. This is that
great deal you just cannot pass up. What would the opportunity cost be? That item you
passed up and substituted for.
The Law of Demand: Simply put, the higher the price, the lower the demand and the
lower the price, the higher the demand. Quantity demanded in inversely proportional to
price.
Demand and “want” are not the same. You might want any number of things, but to an
economist you demand these things when you are willing and able to buy them.
In numbers it would look like so:
Demand Schedule for Cookies
At a price of Consumer will buy
.70 cents
100 cookies
.60
200
.50
400
.40
700
.30
1,100
.20
1,600
.10
2,300
Economists also like to look at things graphically. It enables us to see the quantity and
price on a limitless scale. To do this we plot what is known as a demand curve. The price
is always on the vertical axis and the quantity is always on the horizontal axis. If we were
to plot our points and draw a demand curve for the cookies it would look like this:
What causes demand for products to increase or decrease?
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Changes in incomes: If consumers earn more money they are able to spend more
money and visa versa.
Prices or availability of substitutes: more than one product often satisfies a
consumer’s demand. Changes in demand for a product caused by changes in the
price of substitute products is called the substitution effect.
Price or availability of complementary goods: demand for a product is
influenced by the price of goods or services used with that product. For example,
hot dog buns are generally used with hot dogs. If the demand for hot dogs
suddenly increases, the demand for hot dog buns probably will as well. Products
used in combination with each other are called complementary products. A shift
in the demand for a product will cause a similar shift in the demand for its
complements.
Change in the weather or season: the demand for hot dogs can increase at
certain times of the year. During the summer when people are taking vacations
and cooking out, they usually demand more hot dogs.
Change in the number of buyers: the demand for hot dogs or any other item is
affected by the size of the population a market serves.
Change in styles, tastes, habits: possibly the most common shift in demand
results from changes in consumers’ attitudes. Attitudes towards popular music
shifts quickly.A group or singer in great demand today may be virtually forgotten
in a month.
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Changes in expectations: is the price or availability likely to change in the
future.
Advertising
If changes occurs in any of these 7 factors, the old demand curve is no longer accurate. A
new curve is needed.
In economics there is a concept you must become familiar with, "ceteris paribus" a
Latin phrase which means "all other things held constant". In other words all things
being equal. When examining economic concepts it is a idea that is accepted in all
examples.
According to some economists, a few luxury goods offer a rare exception to the law of
demand. Although consumers will usually choose the cheaper of two goods if their
quality is the same, a seller can set a luxury coat or dress apart from its competitors by
pricing it so high that most people cannot afford to buy it. Consumers with plenty of
money may value the status from buying an exclusive good more than the extra cost of
the item.
Why do prices have this effect? There are three factors that explain why people behave
this way:
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Buying power: if the price of an item goes down, then consumers have more
buying power than before. If the opposite occurs and the price of an item
increases, consumers buying power decreases.
Diminishing personal value: there comes a point where a item no longer means
as much to a consumer as it once did.
Substitutes: are two goods that satisfy similar wants.
Price changes effect all of us. The law of demand controls all our buying patterns. When
we want consumer goods, we express our individual demands in the market. The result is
market demand.
ELASTICITY
Since the laws of supply and demand set price, prices are always subject to change based
upon market forces and the interaction between the consumer and business. This change
in prices and the degree of said change is known as elasticity.
There are two types of elasticity that we need to be concerned with. They are demand
elasticity and supply elasticity.
Demand Elasticity - the degree to which changes in price effect changes in demand.
Demand is elastic when a small change in price effects a large change in demand. Such
products, that show great variability in demand are known to have elastic demand.
Demand is inelastic when a change in price does not bring about a correspondingly large
change in demand, or any change at all. Said products are known to show inelastic
demand.
How can we tell if an item is will be elastic or inelastic? The elasticity of demand can
usually be estimated by examining the answers to three key questions. All three answers
do not have to be the same in order to determine elasticity, and in some cases the answer
to a single question is so important that it alone might dominate the answers of the other
two. Let's examine the three questions.
1. Can the purchase be delayed?
The ability to delay or postpone the purchase of a product is one of the determinants of
elasticity. If the purchase can be delayed, the demand for the product tends to be elastic.
If it cannot be delayed it tends to be inelastic.
For example, since I can wait to buy a new stereo until the price drops demand will vary
greatly in accordance with price. This product thus would tend to be elastic. Gasoline, on
the other hand, I cannot wait for. Thus demand does not vary greatly with price and the
product tends to be inelastic.
2. Are adequate substitutes available?
If a product has many substitutes, the demand for it tends to be elastic. The fewer
substitutes available for a product, the more inelastic the demand. Note we are talking
about product not brand!
For example, if the price of coffee were to go up dramatically then many people would
switch to tea, thus a substitute is available. Since this is the case the price is causing
demand to drop. This product would then be considered elastic. Since there is no real
substitute for gasoline of heating oil, demand remains the same regardless of price. These
products are inelastic.
3. Does the purchase use a large portion of income?
If a product is expensive, and is a large percentage of one's income, then the product
tends to be more elastic. If a product is not a significant portion of the income the product
tends to be more inelastic.
Take a house for example, if prices were to drop, demand would go up a lot. The same
holds true for a car. A bar of soap, steak, clothes, since even an expensive product can be
readily afforded the change in price is not a tremendous factor in demand.